This Is Very On-Brand for Washington

The talk about recession in D.C. today... This is very on-brand for Washington... Wrong once, wrong again?... A recession might be starting right now... Watch the unemployment rate over the next three months... It might never be 'official'...

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Straight from a D.C. insider...

I (Corey McLaughlin) like to catch business-talk radio when I'm in the car...

It's not because I would ever exclusively use it to make investing decisions. But I like to have a sense of what "the street" is saying.

This is often helpful to gauge prevailing sentiment in the market, or at least the media that talks about it, at any given time. Sometimes, we talk about it here in one way or another.

Today, the few minutes was worth it.

It just so happened that billionaire David Rubenstein, co-founder of the Carlyle Group private-equity firm and friend to many an elite in U.S. politics and finance, was a guest on Bloomberg Radio's morning show. And he shared an observation that got my attention...

I don't have the precise quote because I was driving safely, but it went something like this: The feeling in Washington is that the possibility of a recession is behind us.

Now, this isn't exactly new information. Treasury Secretary Janet Yellen has said the same. Federal Reserve Chair Jerome Powell did as well, though he pinned the blame/analysis on central bank economists (of which he is not one, remember... Powell is a lawyer by training).

But Rubenstein was talking about people who work behind the scenes in D.C., the political crowd that talks to each other. He got his start in D.C. as a lawyer in the 1970s, then got into finance, just like Powell. (Rubenstein actually also grew up modestly here in Baltimore, the son of a mailman and a stay-at-home mom.)

Anyway, what he said this morning on the radio is a notable insight on political-class sentiment... It reflects perhaps rising complacency in thinking – or simply wishful thinking or messaging with another election year ahead – that the worst of recent economic times is behind the U.S.

It would be very on-brand for Washington... clueless of, or ignoring, what is actually going on in the rest of the country, including the economy...

Like "inventory shrink," or stealing, on the rise at major retail stores stemming in part from the consequences of 40-year-high inflation...

Or a "resilient" consumer being one who is tapped out of cash and uses a credit card...

Or student-loan repayments finally starting back up again, and what that might mean...

Or the fact that the unemployment rate just went up for the first time in several months.

We can see it now: However many months or a year from now, these same people might say, "Nobody could have predicted this recession," while at the same time firing up the economic-stimulus machines to try to rescue the nation in a crisis, perpetuating the cycle.

It's not just the political class taking this view...

Apparently, the feeling on Wall Street is increasingly leaning toward the idea of the U.S. not experiencing a recession anytime soon...

In a new prediction, Goldman Sachs' economics team recently lowered its chances of the U.S. falling into a recession over the next 12 months to just 15%, down from 20% in July and 35% in March. To be fair, the firm is more optimistic than most others...

A Bloomberg poll of Wall Street firms puts the likelihood of a recession at 60% after the recent jobs data we've reported on that signaled the labor market might be weakening.

Still, that's lower than what the leading odds were over the past year on Wall Street, when it actually was an attractive time to buy stocks, such as last fall when the major U.S. indexes bottomed, or early in 2023 when sentiment was still sour.

As our Director of Research Matt Weinschenk pointed out in our Portfolio Solutions products in January (that entire issue is worth reading again, even if you did the first time)...

Financial media hosts no longer ask for predictions of a recession like they did all through 2022. Rather, they presume the recession is coming, and the conversation is about how long or how deep it will last.

Now, generally speaking, I am sensing the prevailing wind is blowing ever so slightly to the more optimistic view... Maybe this ends up being "right." But no one in the media is even debating the idea of a "hard" or "soft" landing anymore... even though we are only seeing the beginning of the effects of the Fed raising interest rates from 0% to above 5%.

To me, this means it might be time to get a little more cautious, or at least think about getting cautious.

Think of it this way: Some of the same people who were wrong about a recession happening in 2023 (at least so far... there are four months to go) are suddenly not expecting it to arrive at all. So, will they be wrong again?

I'm here to tell you they may have just had the timing wrong – and given up too early. And either way, they're mistakenly relying on the "official" definition of a recession that only comes well after the contraction actually begins, if ever.

A recession might be starting right now...

We're still digesting the latest jobs report from Friday. More than one analyst is calling it a "Goldilocks" report, meaning it showed the labor market slowing, but not by too much, essentially not changing the story for the economy right now.

With inflation coming down and the jobs market weakening, but not cratering, it gives credence to the thought that the Fed might "pause" interest-rate hikes this month and see if these trends continue in the ensuing weeks. This avoids upsetting the expectations apple cart.

But that's right now. We want to think about the future. Now, I do not speak for any or every Stansberry Research analyst or editor. Different people may have different opinions. But to me, the latest jobs report from Uncle Sam is worth a heavy dose of consideration...

It showed a statistically significant uptick in unemployment for the first time since May (it bounced from 3.4% in April to 3.7% before falling lower).

The unemployment rate for August came in at 3.8%, up from 3.5% in July. As I wrote back in the May 9 Digest, this is a key metric – maybe the key metric – to watch when it comes to gauging whether a recession is in the making.

We shared then that veteran investor Tony Dwyer, who has 30 years in the markets and is the chief market strategist for Canada-based Canaccord Genuity, said that two things will eventually wake up people to the fact we're having a recession...

1. Yield curves will turn positive, or I would say start to turn positive. This is the opposite end of the predictive nature of the "inverted" yield curve – when shorter-term yields are higher than longer-term ones – which has proceeded all 10 recessions since 1955...

When the yield curve "reverts" from upside-down territory, it has historically coincided with the actual recession itself. In the last four "official" recessions, they were deemed to have started when the Treasury yield spreads were comfortably positive and on the rise after being negative. This isn't the case today.

But in the similar high-inflation 1980s, a recession officially began – a designation called in hindsight, remember – when the curve started to get back to normal yet remained in negative territory. We might be seeing this right now. All of a sudden, the 10-year/2-year Treasury spread has moved from negative 1% in July to negative 0.7% today.

That's a big move.

On a related note, recession predictor that the New York Fed publishes based on Treasury-spread behavior puts the odds at 70%. That's the highest they've been since the early 1980s.

2. The unemployment rate will rise over a sustained period, specifically to an average of 50 basis points (0.5 percentage points) higher than the low of the cycle for three straight months.

This second one is called the Sahm Rule in finance circles. It's named for Claudia Sahm, a former Fed economist and not coincidentally a member of the National Bureau of Economic Research ("NBER"), the body that makes recession calls that go in the history books.

Watch what happens with unemployment over the next few months. As I wrote back in May...

Using current numbers and timing, that would mean to watch for when unemployment hits 3.9% for three straight months, as the most recent unemployment data for April checked in at 3.4%.

This still holds true.

The 3.4% unemployment rate from April has so far stuck as the low of this cycle.

Now, as of last month, the rate has climbed to 3.8%. That's not at 3.9% yet, but it's pretty darn close. And if the jobs market continues to weaken as it did last month, it shouldn't be long before the U.S. government is reporting a 3.9% unemployment rate.

Once we've had three straight months of that, or higher, you'll hear a lot more people saying a contraction is happening – except in D.C.

This might not end up being an 'official' recession...

But you don't need that designation to feel economic pain. Remember, the two straight quarters of declining GDP in the first half of 2022 didn't count as an "official" recession either.

Back then, the inflation rate was still very, very high, but unemployment was still low and heading lower in some months, so the shot-callers at the NBER never pulled the trigger on a call... It didn't meet all their criteria.

The markets didn't care. Stocks sold off in volatile fashion and eventually bottomed in October with the benchmark S&P 500 Index down 20% and many individual stocks off much more.

Should unemployment rise – and the inflation rate keep coming down – GDP could keep growing this time around. We might never get an "official" recession call. But there are various risks that could upset the "Goldilocks" story.

Either way, when enough people are looking for paying work and can't find it, that's not a sign of a strong economy... or a nation full of warm and fuzzy feelings.

Practically, more unemployment means people will have less ability to spend and are maybe maxed out on borrowing ability. This could lead to lower earnings outlooks for companies, perhaps lower stock prices, and various other consequences.

Tomorrow, I will get into a little bit more about those. I'll also share a buying opportunity in a sleepy sector of the market that you may want to consider adding exposure to today – before anyone starts raising their odds of a recession coming again.

New 52-week highs (as of 9/1/23): Adobe (ADBE), Applied Materials (AMAT), Array Technologies (ARRY), Brown & Brown (BRO), Cameco (CCJ), CyberArk Software (CYBR), Comfort Systems USA (FIX), Intuit (INTU), Iron Mountain (IRM), Eli Lilly (LLY), MSA Safety (MSA), NVR (NVR), VanEck Oil Services Fund (OIH), Phillips 66 (PSX), Rithm Capital (RITM), SLB (SLB), TFI International (TFII), Sprott Physical Uranium Trust (U-U.TO), Global X Uranium Fund (URA), United States Commodity Index Fund (USCI), Visa (V), and Verisk Analytics (VRSK).

We're back from our Labor Day break... In today's mailbag, feedback on Mike Barrett's Masters Series essay from Sunday... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"[Mike wrote]...

Strong capital markets and historically low, near-0% interest rates encouraged U.S. corporations to go on a 'buy growth' binge before and during the COVID-19 pandemic. As a result, investors priced stocks to perfection, assuming this acquisition-fueled growth would continue for years to come.

"Did Powell signal something? Those who loaded up with effective 0% interest are sitting pretty right now while the rest are not. It does not pass the smell test with flying colors. And would be just one more gift from our privately owned central bank/fake Fed. At 85 nothing surprises me anymore." – Subscriber Bernie B.

All the best,

Corey McLaughlin
Baltimore, Maryland
September 5, 2023